Why Google <3s Groupon

The Google-Groupon acquisition rumors are coming in hot and heavy now. The day began with a rumored price of $2.5 billion, which was way too low. Now it ends with a more likely price somewhere between $5 billion or $6 billion. Whatever the price, it will likely be Google’s largest acquisition ever if it goes through (beating out DoubleClick’s $3.1 billion, and certainly YouTube’s $1.65 billion price tags).

But why is Google even interested in Groupon? It is essentially an e-commerce site, bringing consumers daily deals from local and national merchants. Google doesn’t do e-commerce very well (although it is trying through sexier product search). Buying Groupon would be a very risky $5 billion bet for Google in an unproven area outside its sweet spot of search I won’t even get into valuation, which at $5 billion would be somewhere in the neighborhood of ten times whispered revenue run-rate of $500 million. But Groupon is the clear market leader in the fastest growing new category on the Internet, and Google seems willing to pay whatever it takes to buy market leadership. As one CEO in the local commerce industry put it to me on Monday, “I think the way Google will evolve is they will want to control everything significant on the Internet.”

Local commerce is one of those opportunities where Google is putting a lot of wood behind the arrow. Google Places is increasingly front and center on the main search results page for local searches, and VP Marissa Mayer recently switched from Search to now running Location and Local Services. She is known to be a big fan of Groupon, and now it will likely become a business under her direction.

But if there is one thing that explains Google’s affinity for Groupon is its pay-for-performance model. Groupon doesn’t get paid by merchants unless it delivers customers to their doors in the same way that Google does not get paid by search advertisers unless it delvers clicks to their websites. Through its online-to-offline coupons, Groupon has figured out how to track that last mile in local online commerce between the ad and customers showing up at a store.

Google could start showing Groupon deals as tags on local searches or within Google Maps. The ability to add deals to their Places pages could make Places more appealing to local businesses as well. The biggest challenge for Google will be scaling the business from one which deals with a few hundred businesses per day to tens or hundreds of thousands. Groupon still requires a large local sales force to manage these deals, and an army of copy writers to make the deals appealing. The larger Groupon gets, the harder that becomes. And those reputed 50 percent margins are begging to collapse. With a $5 billion price tag, there will be no margin of error for Google on this deal.